How to Retire Early

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It might be the most common cubicle daydream: early retirement, and the freedom — financial and otherwise — that comes with it.

But some workers are making it a reality by joining the FIRE movement, which stands for “financially independent, retire early.” They’re retiring in their 40s, 50s or even earlier to travel, pursue passion projects or simply not work.

FIRE has essentially redefined early retirement, making it less about leaving work and more about having the financial independence to decide when, how and for whom you work.

How to retire early

Ironically, retiring early requires a lot of work.

After all, there’s a reason most people still work into their 60s (and frequently reach that age without much retirement savings to speak of). But with some strong resolve and a few solid strategies, early retirement doesn’t have to be a pipe dream. Here are five key steps to take:

1. Make some adjustments to your current budget

Here’s where that work comes in: No matter how you want to slice it, retiring early means making some changes to how Current You earns and spends money, so Future You gets to relax. And for many people, that means cutting their budget to the bare minimum. Many people with early retirement ambitions aim to live on 50% of their income (or less). The rest gets funneled into savings.

FIRE devotees have all kinds of strategies for getting their spending down to this level, ranging from the obvious to the insane. Wiping out debt — including debt traditionally considered “good,” like mortgage loans — is key, as is cutting large and small expenses. You’ll want to get creative about how you can save money on transportation, utilities, food and housing costs. Do you have a bike? Get ready to ride it.

It’s also wise to find ways to bring in some extra income that can go directly into your early retirement coffers. There are actually two groups of FIRE devotees: The lean FIRE group, which aims to live as lean as possible, and the fat FIRE group. Followers of fat FIRE focus less on frugality and more on increasing their earnings — either through investments or side hustles — so they can live a comfortable lifestyle and retire early. If that sounds more appealing to you, don’t get rid of the car just yet. You’re going to need it when you start driving for Lyft.

2. Calculate your annual retirement spending

The good news about Step 1: You’re probably used to living on just a small portion of your income.

That, in turn, translates into needing less money for retirement — the assumption being you’ll continue to do so. Prove that out by putting together a retirement spending estimate. To do that, take a look at your current monthly spending and consider what will go down, what could go up, and what might be added or eliminated altogether.

Add your final monthly expense estimates up, multiply by 12 and you have the magic number: your annual retirement needs. To make it truly magical, we’d recommend increasing it by 10% to 20% so you have some wiggle room. You never know when you’ll want to splurge on a haircut.

Two things that are frequently overlooked during this tally, both of which could put an early end to your early retirement: taxes and health care.

Two retirement expenses that are frequently overlooked: taxes and health care.

Health care in particular is a real hitch in many plans, especially for those who get their health insurance through work pre-retirement. Leaving that job means leaving your policy behind. Some options for replacing it: If you’re married and your partner is still working for the man, the easy solution is to monkey onto his or her plan. Otherwise, consider purchasing private insurance or searching for a plan through the Affordable Care Act marketplace. (Losing existing coverage counts as a qualifying life event, making you eligible for enrollment outside of the annual open enrollment period.)

You could also look for part-time work with health coverage — Starbucks and Costco are two FIRE darlings for extending health insurance to part-time employees — or see if you qualify for an industry association that offers group coverage. COBRA, a costly way of continuing your workplace policy for up to 18 months by covering all of the premiums yourself, should probably be a last resort.

And now for everyone’s favorite subject, taxes. The goal, as always, is to minimize them. To do that, you’ll want to strategize about how and when you pull income from your investment accounts.

Keep in mind that many tax-advantaged retirement accounts, like 401(k)s and IRAs, have rules for when you can take qualified distributions, in most cases requiring a minimum age of 59½ to avoid taxes and penalties. (The exception: Roth IRAs, which allow you to distribute contributions — but not earnings — at any time.)

There are a few exceptions to the early distribution rules. One popular among early retirees is to start a series of substantially equal periodic distributions, which are allowed by the IRS provided you follow specific protocol. We’d recommend working with a financial planner to develop a strategy for tapping your investments while ducking taxes — where you can — and avoiding penalties. Here’s how to choose the right advisor for you.

3. Estimate your total savings needs

The work you did to nail down spending already has you halfway through this one, thanks to a couple of rules of thumb widely used by early retirees.

The first is the rule of 25: You should have 25 times your planned annual spending saved before you retire. That means that if you plan to spend $30,000 during your first year in retirement, you should have $750,000 invested when you walk away from your desk. $50,000? You need $1,250,000. Incidentally, this is good motivation to get that budget in check.

You should have 25 times your planned annual spending saved before you retire.

The rule assumes that your retirement nest egg is invested so it continues to grow — after all, thanks to inflation, your spending will increase at least slightly each year, and your investments need to keep up with that. Which brings us to the second rule: the 4% rule, which indicates you can withdraw 4% of your invested savings during your first year of retirement. Each year after, you draw that amount adjusted for inflation.

The 4% rule stems from research in the 1990s that tested a variety of withdrawal strategies against historical market conditions. You may want to take a more or less conservative approach, depending on your investments, risk tolerance and how the market is performing when you retire.

But there remains this disclaimer: Neither of these rules is foolproof. You’d be hard-pressed to find a financial advisor willing to guarantee your results. But they’re generally considered reasonable strategies.

4. Invest for growth

At the risk of stating the obvious, retiring early means (1) you have a shorter period during which you can save, and (2) you have a longer period during which the money you’ve saved needs to support your spending.

Both of those mean investment returns are going to be your best friend. And to achieve the best returns, you need to invest in a balanced portfolio geared toward long-term growth. We recommend low-cost index funds, with an allocation that is tilted toward stocks for as long as you can stomach it.

You may think the opposite is true: Because you have a shorter time horizon before retirement, you should take less risk. But it’s important to remember that the time you spend in retirement should be included in that horizon — you might be retired for 50 or 60 years; you need your money to continue to grow during that time.

As you approach your planned retirement date, you will likely want to shift a small amount of your savings into safer, more liquid havens, so you can tap it without worrying about selling investments at a loss. Perhaps you do that with a year or two’s worth of expenses. But the rest should remain invested, slowly shifting to cash as you need it, so your money grows and supports that 4% distribution rate discussed earlier.

5. Keep your expenses in check

You’ve done a fair amount of work estimating how much you’ll spend in retirement. The harder job will be actually sticking to that estimate.

It starts small: You throw yourself a retirement party. Then you find yourself with some extra time on your hands — you’re retired, don’t forget — so you plan a vacation, mindlessly browse stores, take up gourmet cooking or adopt a dog. Suddenly that 4% has a one in front of it.

Don’t do that. Not to state the obvious, but the 4% rule only works if you stick to the rule. It’s designed to allow your spending to increase with inflation, but not to withstand large spending increases beyond that. Each spending increase — particularly recurring expenses, like a new debt payment — increases your likelihood of running out of money.

It goes without saying, but we’ll say it anyway: For most people, running out of money means running back to work.

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